Alas, the Feds Take Over Student Loans

As an observer of the national political scene for over a half of a century, and as a former employee of the U.S. Senate, I have seen a lot of political sleaze and chicanery. But nothing tops what happened as the Congress, using a relatively arcane procedure designed to correct spending excesses in budget bills, radically changed a system of federal student loans, against the wishes of millions of users, against many colleges whose tuition fees necessitate the loans, and, most shamefully, against the wishes of probably a majority of the Congress itself.
The Obama Administration will be taking private providers, with one exception, out of the business for servicing federally subsidized student loans. I believe the reason for this is largely ideologically driven -a deep distrust and contempt for private business, and a belief in governmental control if not ownership of the means of production (which we used to call socialism). But the stated rationale is that this is to save money – over $60 billion over a decade -to fund needed expansion of Pell Grants, among other things.
I don’t like the student loan provisions of the new law for many reasons. First, as indicated above, it is an affront to the democratic process on which this nation was founded. Proponents of the student loan changes had come to realize that they very likely would not be able to get them through the House and the Senate, so they stuffed them into the health-care legislation. Members of Congress who supported the health-care bill but opposed the student loan changes were forced to vote contrary to their wishes on one or the other of those issues.
Second, the alleged $60 billion in savings under the bill are highly dubious in a narrow technical sense -and non-existent if a broader perspective of savings is used. It is true that the Feds do make payments to private providers servicing loans, and it may well be that ending the payments will reduce cash outflows from the Treasury, although even here there are good reasons to be suspicious of the $60 billion figure.

In earlier calculations, for example, no account was taken of the lost corporate income tax revenues that the Feds would receive on account of falling profits of loan providers (I don’t know if that omission has been corrected). The calculations, correctly done, are also sensitive to assumptions about the term structure of interest rates, which almost certainly will change significantly in coming years (I think interest rates will explode because of impending inflationary policies to try to ease the pain of massive budget deficits). Remember that the funds the Feds will loan students are borrowed monies (given budget deficits) -and the government has to pay interest itself on borrowed funds – and it is not only plausible but likely that those payments will rise significantly. Under one plausible scenario, the narrowly defined savings under this bill approaches zero.
Third, in a broader sense, the true societal savings under this new law are almost certainly negative, since there will be a very significant decline in services provided students wishing to borrow. Let me use an analogy. Decades ago, the U.S. Postal Service was the only major game in town if you wanted to send someone a parcel. Even today, U.S. Postal Service parcel delivery is often cheaper than private alternatives. Yet a huge proportion of parcels are now delivered by private providers like UPS and Fed Ex, because they provide speedier, more reliable service. What the Feds are doing is the reverse: putting UPS and other competent deliverers out of business and leaving us with the equivalent of the Post Office. Monopolies are inevitably and always inefficient. Private providers talk to students, give them useful information. Now, no doubt, students will be given one-size-fits-all generic advice online or in recorded phone messages.
Fourth, let me talk about the one exception regarding private loan provision. According to yesterday’s Wall Street Journal, the bill allows certain nonprofit providers close to Democratic politicians help the U.S. Department of Education in the servicing of loans. How much these providers will kick back to the politicians in the form of campaign contributions, I do not know, but this law is not only bad, but it has a smell of corruption around it as well.
Fifth, as Peter Wood of the National Association of Scholars points out, the increased federal intrusion into university affairs increases the possibility of federal interference with curricula and academic freedom. I can see some activist bureaucrat trying to force the College of William and Mary to remove the cross from the Wren Building, or Hillsdale College to have some left-wingers included in their lecture series in the interest of intellectual diversity. While the government has been constrained in this area to this point, for example, not forcing Catholic schools to remove crucifixes from classrooms, the greater the governmental involvement the greater the probability they will start messing around with curricula and fundamentally threaten the culture of many institutions.
Sixth, my most fundamental objection is that the Feds do not belong in the student-loan business, and that true reform would involve a phasing out of loan subsidies. The subsidies have served to raise tuition fees, so the gains from the loan programs likely accrue more to the colleges and their staffs (including me) than to students. The federal loan subsidies have probably increased, not decreased, economic inequality in the United States by helping finance the growing disparity between students attending elite private schools and the typical state university. Most important here, the allocation of financial resources should be determined by market considerations, not politics. Politicians should not try to dictate interest rates, or say to whom loans should be made. Inevitably this fundamentally distorts the allocation of scarce resources.
I have still other objections as well. My colleague Andrew Gillen and I have shown some sympathy for Pell Grants, which could serve as a basis for a more rational, voucher-like, approach to governmental subsidies, if such subsidies must be made. Indeed, while serving on the Spellings Commission I publicly advocated getting rid of all federal student assistance programs except Pell Grants. Yet attempts to make them an entitlement -as was partially accomplished in this new law – likely will lead to a corruption of the goals of the Pell Grant program (equal education opportunity), and also to all sorts of unintended consequences, including, potentially, greater dropout rates, higher tuition fees, etc. We are in the beginning of the era of the unemployed or underemployed college student, washing dishes or delivering mail with a bachelor’s degree or more, and this bill will further that tendency.
Immoderation sometimes leads to unintended consequences, and it is possible that by adding student loans and doing other irrational things (e.g., raising taxes at the margin on the most productive portion of the population) to the already nearly incomprehensible health care bill, that the Democratic leadership will lose the broader war for the support of the American people after winning the big battle. After all, it is barely 200 days to Election Day. Stay tuned.


  • Richard Vedder

    Richard Vedder is Distinguished Professor of Economics Emeritus at Ohio University, a Senior Fellow at the Independent Institute, and a board member of the National Association of Scholars.

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